Jack Welch Set the Bar Too High?

Jack Welch, the former CEO of General Electric, is known far and wide as a brilliant business executive. But the recent issue of Barron's reveals that some of his apparent success may have been due to other factors:

Jack Welch, General Electric's demanding former chief executive, delighted in setting the bar high. When he stepped down a few days before Sept. 11, 2001, he left his successor, Jeffrey Immelt, the challenge of matching a remarkable string of years of strong profit growth. What was most remarkable about those years, however, wasn't apparent to anyone outside the company until recently. The bar might have been set artificially high.

During the last five years of the Welch era, ended in 2001, GE's reported earnings jumped from 72 cents a share to $1.37, a rise of 65 cents a share, or 90.2% -- spectacular for a behemoth like GE. But without a massive under-reserving at its reinsurance unit, the company would have shown a cumulative earnings gain of just four cents, or 5.6%. [Barron's, December 26, 2005]

Those who follow corporate finance know that there's a big difference between a cumulative gain of 65 cents vs. 4 cents over five years. But numbers can be tricky, and even the best fundamental analysts can't ward against this sort of fudging.

That's just one reason why it's useful to be knowledgeable about technical analysis, which follows patterns in price charts, rather than depending on fundamentals, such as a company's reported earnings. For a fuller discussion of why technical analysis becomes more fashionable than fundamental analysis when it does, read this excerpt from Bob Prechter's current December Elliott Wave Theorist.

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In September 1929 at the top, the president of the New York Stock Exchange famously announced, "It is obvious that we are through with business cycles as we have known them." Just a decade later, after two giant bear markets back-to-back, Joseph Schumpeter of Harvard called the Kondratieff cycle theory "the single most important tool in economic forecasting." In 1999 at the top, economists declared a "New Economy," where cycles were obsolete and stability would last forever.

As the bear market progresses, this idea will dissipate, and waves and cycles will be discussed again in academia. The reason is simple but deceptive: People equate uptrends with certainty and normality and downtrends with uncertainty and abnormality. When the trend is up, they are confident that things are as they should be, they know why, and they accept the credit for it. When the trend is down, they search for theories to explain why they were caught off guard and why they don't deserve the blame for what happened. Of course, all trends are normal and none of them is consciously engineered; it's just that people don't always see them that way.

In February 2000, the Elliott Wave Theorist added this observation:

The widespread acceptance of the idea that economic cycles are dead answers the question of why we have economic cycles. People's beliefs about trends are not scientific but emotional. When markets have gyrated, they believe in cycles. When they go down for a long time, they believe in doomsday. When they go up for a long time, they believe that cycles are dead and the only possible direction is up. If people were different in terms of being intellectually independent and commonly expecting trend change, then financial markets would be far more stable.

Recent events have supported the connection between social-mood trends and the shifting view of the validity of technical analysis. In 1982, after 16 years of sideways markets (and four recessions), the majority of interviewees on Financial News Network (FNN) were technicians. By the late 1990s, after many years of advance, the vast majority of interviewees on CNBC were economists and money managers, which is still the case.

In the 1970s, the Merrill Lynch Market Analysis Department boasted a staff of 15 technical analysts. By the late 1990s, it had slowly slipped to one-third its old size. In recent dramatic developments, as the Dow has held tirelessly near its all-time highs in an environment of historic market optimism (by multiple measures), brokerage firms have fired prominent technicians.

Morgan Stanley let three out of four technicians go in January 2002, right at a rally peak;

Citigroup's Smith Barney let Louise Yamada and her staff go last February, days from the Dow's high for the year to date;

Prudential did the same with Ralph Acampora and his group in October.

The firings of technical analysts in 2005 have the same implications, both for the stock market and for technical analysis: As the Theorist said in April 2005, "Citigroup's Smith Barney brokerage unit dismissed the entirety of its 10-person technical analysis group. The cutback … is a great big sell signal for money-center banks and a buy signal for the field of technical analysis." Technical analysis's new uptrend, barely visible now, has a long way to go.

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